Are annuities a worthwhile
Is an annuity a good investment? -- Genevieve
Annuities are investment products that have an insurance
component and are backed by the financial strength of the insurance company that
structures the investment.
name comes from the investor's ability to convert the investment into a stream
of periodic income payments (an annuity) either over the annuitant's life or a
set number of years. Conservative investors like the idea of an annuity because
they like the certainty of an income stream over their life expectancy.
offer a measure of protection against market downturns, may provide a guaranteed
investment return, and grow tax-sheltered until you withdraw the money. They are,
however, seldom the right choice for tax-advantaged retirement accounts like 401(k)
plans or IRA accounts.
There are fixed annuities and variable
annuities. In general, the return on a fixed annuity is contractual during both
the accumulation phase (contributing to the account) and the annuitization phase
(taking contributions from the account). That's why it's called a fixed annuity.
It doesn't mean that the rate can't vary over time; it means that how the rate
changes is stipulated in the annuity contract.
With a variable
annuity you invest in sub-accounts during the accumulation phase. The investment
return depends on the investment performance of the sub-accounts you choose. Your
choices in sub-accounts mimic the choices you would have in a family of mutual
Variable annuities are often expensive investments to
own. You pay for the insurance component, called mortality and expense risk charge
(M&E). The average annual M&E charge on an annuity is about 1.15 percent.
The variable annuity sub-accounts also have investment administration
expenses. These annual expense ratios vary depending on the sub-account, but .45
percent to 1.25 percent isn't uncommon. You can easily wind up paying up to 2
percent annually on M&E and investment management fees. That creates a drag
on the variable annuity's investment return.
have surrender charges if you withdraw your money from the account in the first
six to eight years. The surrender charges are typically 6 percent to 8 percent
in the first few years and decline over time to 0 percent. If you change your
mind about investing in the annuity, you could pay a steep price to get out of
A Tax-free Section 1035 exchange will allow you to move
from one annuity to another without a tax effect, but you can't avoid surrender
charges by making a Section 1035 exchange.
Some annuity providers
offer bonuses as an incentive to get you to transfer to their variable annuity
product. The logic is that they are compensating you for the surrender charges
you'll have to pay in getting out of your existing annuity. The downside is that
you'll start all over with a new surrender period for the new annuity, and the
charges and terms of the new annuity may be more expensive than the original annuity.
The Securities and Exchange Commission has a very good
online brochure concerning variable annuities. Investors considering purchasing
a variable annuity should be sure to read this publication before starting to
shop for a variable annuity.
Readers interested in learning
more about fixed annuities can find additional information on Annuity.com
Talk to your tax professional before investing in any annuity contract, and make
sure you understand the annuity's annual fees and expenses before investing.
long-term investors don't need the insurance feature of annuity investments and
would be better off in other investments. The basic insurance feature guarantees
that you won't lose money due to market downturns by investing in a variable annuity.
The longer you own the variable annuity, the less likely it is that you will lose
all your investment gains and benefit from the insurance provisions.
stock market's performance over the past two years has reminded investors that
stock prices can go down as well as up, but paying M&E expenses over time
hurts your investment's average annual return. Most investors would be better
off considering annuities as a last resort rather than a first choice when it
comes to creating an investment portfolio.